Sunday, April 19, 2015

I have started
to write a blog for Forbes, and I hope you will follow my blogs there. I
provide the link below. However, I will keep posting the blogs here as well as
I sometimes write a longer text than what is published online.

Over
the last 40 years, we as individuals have been given increasing responsibility
for ensuring our own financial well-being in retirement. But it’s gotten quite
complex, with an alphabet soup of retirement saving vehicles – from 401(k) to
403(b) plans to IRA and Roth IRAs – and our responsibilities loom large. Not
only must we figure out how much to save and how to invest our retirement assets,
but we also must take advantage of a variety of tax-favored assets, employer
matches, payout options, and much more.

In
my research,
I investigate how well-equipped we are to make such complex financial decisions.
For instance, how much do we know about the power of compound interest, so we
can appreciate how critical it is to save early and grow our money tax free? Do
we know how to diversify risk? Such knowledge provides a firm foundation for
good financial decision-making over the entire lifetime.

To
gain an understanding of the level of financial literacy in the population,
Olivia S. Mitchell and I designed and fielded three key questions which have
now been used in a large number of national and international surveys. We have
also administered the survey to a variety of employees at large companies, to
see exactly what they know – and don’t know.

Try
the quiz yourself (right answers are in bold)

1. The Interest Rate question (Numeracy)

Suppose you had $100 in a savings
account and the interest rate was 2% per year. After 5 years, how much do you
think you would have in the account if you left the money to grow?

More than $102

Exactly $102

Less than $102

Do not know

Refuse to answer

2. The Inflation question

Imagine that the interest rate on your savings account
was 1% per year and inflation was 2% per year. After 1 year, how much would you
be able to buy with the money in this account?

More than
today

Exactly the
same

Less than today

Do not know

Refuse to
answer

3. The Risk Diversification question

Please tell me whether this statement is true or false:
“Buying a single company’s stock usually provides a safer return than a stock
mutual fund.”

True

FalseDo not know

Refuse to answerOur
findings in the US and around the world proved to be shocking! Only one-third of
Americans can answer all three questions correctly. And while one might expect that
the more experienced would be substantially more financial literate, this is
not the case. In fact, older adults are not much savvier than the young,
despite their having had to make many financial decisions including about
retirement savings. We also find that financial illiteracy is particularly
severe among certain demographic groups, such as the low paid, women, and young
adults. Moreover,
when we take our financial literacy survey abroad, the results are not much
better! Respondents in Australia and Germany do perform better, while thus far
we see respondents in Eastern Europe and Russia are the least financially
savvy. But all of us have a long way to go.

I
worry a great deal about such low levels of financial literacy, because retirement
planning requires a modicum of financial sophistication -- and planning is a
strong predictor of retirement wealth. According to our research, those who
plan accumulate up to three times the amount of wealth of non-planners. The
data shows the link to financial literacy is very strong; it is those who are
financially literate that plan for retirement. And without basic financial
skills, people get into trouble young, taking out payday loans and overdrawing
their credit cards, and they stay in trouble later, by failing to pay down
their mortgages and borrowing against their retirement accounts.

Granted,
raising our nation’s financial savvy will require costs and effort.
Nevertheless, there are costs of ignorance, including not saving, not being
able to retire, and being poor during one’s later years.

Saturday, April 18, 2015

I have started to write a blog for the Wall Street Journal, and I hope you will follow my blogs there. I provide the link below. However, I will keep posting the blogs here as well as I write a longer text than it is published because there is a hard word limit at the WSJ.

More than ever before, we must make financial
decisions that are important and consequential. How much should we contribute
to retirement accounts and how should we invest our retirement savings? Should
we enroll in a health insurance plan with a low or high deductible? What do we
need for our children’s education? Household finances have become sufficiently
complex that simple intuition or the advice of family and friends is not enough
to guarantee good choices.

There are courses in corporate finance and
specialized curricula for managing firms’ finances, but what is available when
we serve as our own Chief Financial Officer (CFO)? Fortunately, personal
finance is a subject making its way into schools, from high schools to colleges
to graduate programs. Online courses are also springing up, and some employers
have started to offer financial education programs to their employees.

What should the content of such courses be? As
member of the Board of Directors of the Council for Economic Education, I served as an adviser on the National
Standards for Financial Literacy. From these standards, we can identify some
of the crucial concepts that everybody needs to make informed financial
decisions. I am going to focus on just three, the Big Three as I tell my
students.

One fundamental principle of personal finance is the
power of interest compounding. This knowledge is key for saving, borrowing, and
investing decisions. It enables us to understand, for example, why it is
important to start to save early. And we need to do calculations to see
results. If I borrow at 20 percent on my credit card, how long does it takes
before my initial debt doubles? If expenses and fees reduce my rate of return
by one percentage point, how is my wealth affected over a 30-year horizon?

Because financial decisions are inherently about the
future, we must consider how money’s purchasing power changes over time. We
must also acknowledge that the future is uncertain. That brings into play two
more building blocks: knowledge of inflation and risk. Distinguishing between
real and nominal values is essential to keeping a stable standard of living
over a lifetime. Indeed, personal finance is where we can fully appreciate the
critical role the Fed and its monetary policy play, especially when it comes to
low and stable inflation and its implications for financial planning.

Knowledge of risk and risk diversification is at the
basis of portfolio choice. We can formally prove that the old adage “do not put
all of your eggs in one basket” is, indeed, good advice. Even more, we can
learn how to implement it well. Moreover, we can protect ourselves and our
wealth from the many sources of risks: interest rate risk, health risk, and the
risk of living too long!

The Big Three are the stanchions of a personal
finance course we launched three years ago at the George Washington University
School of Business. While I cannot say whether this course will lead to smarter
financial decisions, students’ eagerness to enroll, performance on the tests,
and comments when they complete it give me much hope.

My picture

About Me

Annamaria Lusardi is the Denit Trust Endowed Chair of Economics and Accountancy at the George Washington School of Business. Previously, she was the Joel Z. and Susan Hyatt Professor of Economics at Dartmouth College. She has taught at Dartmouth College, Princeton University, the University of Chicago Public Policy School, the University of Chicago Booth School of Business and the Graduate School of Business at Columbia University. From January to June 2008, she was a visiting scholar at Harvard Business School. She has advised the U.S. Treasury, the U.S. Social Security Administration, the Dutch Central Bank, and the Dartmouth Hitchcock Medical Center on issues related to financial literacy and saving. She is the recipient of the Fidelity Pyramid Prize, awarded to authors of published applied research that best helps address the goal of improving lifelong financial well-being for Americans. She holds a Ph.D. degree in Economics from Princeton University.